Traders can place different types of orders when investing in the stock market. Each order has a specific purpose, and it’s essential to understand the differences between them to make the most informed decision possible when trading. We’ll take a closer look at some of the most common types of stock orders and what they entail.
What is a stock order?
A stock order is simply an instruction to buy or sell shares of a particular stock. When you place an order, you’re telling your broker how many shares you want to buy or sell and at what price. Your broker will then execute the trade on your behalf.
Stock orders come in various types. The most important are market and limit orders. Stop losses, or stop orders, are a risk management tool. By developing your understanding of all three types you can improve your trading performance.
What is a market order?
A market order is the most straightforward type of order. When you place a market order, you’re instructing your broker to buy or sell shares of a particular stock at the best available price.
For example, let’s say you wanted to buy 100 shares of Company XYZ. XYZ is currently trading at $10 per share. If you placed a market order, your broker would buy the shares for you at the current market price. So, in this case, you would pay $1,000 for the shares (100 x $10).
The main advantage of a market order is that it will be executed quickly. However, there is no guarantee you’ll get the exact price you’re looking for. In a fast-moving market, the price of a stock can change rapidly, and you may end up paying more (or less) than you anticipated. Market orders do not protect you from risk.
What is a limit order?
A limit order is an instruction to buy or sell shares of a stock at a specific price or better. Unlike a market order, executed immediately, a limit order will only be executed if the stock reaches the specified price.
Let’s say you wanted to purchase 100 shares of Company XYZ, but you only wanted to pay $9 per share. You would place a limit order for 100 shares at $9. Your order will never be executed if the stock never reaches that price. However, if the stock does reach $9 (or falls below it), your broker will buy the shares for you at that price (or better).
The advantage of this order is that it gives you more control over the price you pay for a stock. However, there is no guarantee that your order will be executed, and it may take some time for the stock to reach your desired price. Particularly if the price hovers just above your target prize, this can be frustrating. Limit orders are typically used for very volatile stocks. This is to avoid massive one day moves wiping out the profit margin of the trade.
What is a stop order?
A stop order is an instruction to buy or sell shares of a stock once it reaches a specific price. Stop orders are typically used to limit losses or lock in profits. Most traders advise always using a stop loss.
Let’s say you bought 100 shares of Company XYZ at $10 per share. You might place a stop order at $9, which would instruct your broker to sell the shares if they fall to that price, and this would limit your losses to $1 per share. Alternatively, you could place a stop order at $11, instructing your broker to sell the shares if they rise to that price, and it would lock in a profit of $1 per share.
The main advantage of a stop order is that it can help you limit your losses (or lock-in profits). However, there is no guarantee that your order will be executed at the desired price, and the stock may fluctuate before it reaches the specified price.
Stop orders can be adjusted after the trade is made. If an open long trade seems to struggle after initially performing well, many traders will move the stop loss to breakeven. This means even if the trade breaks down there will be no loss.
Some traders consider it poor form to alter stops too much. Their rationale is that you need to confirm your hit rate on the strategy you set out with. Particularly for algorithmic or rules-based traders adjusting stops can become a concern.
What is a trailing stop order?
A trailing stop order is similar to a stop order but adjusts automatically as the stock price moves. Let’s say you purchased ten shares of Company XYZ at $10 per share. You might place a trailing stop order with a 5% stop, which would adjust the stop price automatically as the stock price changes so that it’s always 5% below the current price. Normally there is a lower limit on the trailing action.
For example, if the stock price rose to $12, the stop price would adjust to $11.40 (5% of $12 is $0.60, and $12 – $0.60 = $11.40). If the stock price fell to $9, the stop price would adjust to $8.55 (5% of $9 is $0.45, and $9 – $0.45 = 8.55). This protects your profits.
The main advantage of a trailing stop order is that it protects your profits. The advantage over a normal stop is it adjusts upwards with price. However, there is no guarantee that your order will be executed at the desired price, and the stock may fluctuate before it reaches the specified price.
Most trailing stops have a floor below which they will not decline. This prevents the stop loss from declining with the underlying down to zero.
Trailing stops also have the advantage of preserving your risk reward ratio. If you need to make a 10% profit, you might want a 2:1 risk reward ratio. This requires a -5% stop.
To make the best trading decisions possible, it’s crucial to comprehend how each order differs from the others because each one serves a certain function. You can do your homework about some of the most typical stock order types and what they include in more detail.
Find more info on stock orders at Saxo.
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